Beware of Inflated Charity Efficiency Claims!

Published 12/01/2006

When I founded the American Institute of Philanthropy 14 years ago, I often said that there is a vacuum of independent information available to help donors make giving decisions. Now in 2006, particularly as a result of the Internet, Americans are being inundated with charitable giving information. The problem is that most of the information out there is either directly from the charities who are hesitant to criticize themselves for fear of losing contributions, or unexamined compilations of charities' self-reported information.

What makes AIP particularly useful is that we perform an analysis of a charity's finances to give you a better understanding of how a group's funds are being spent or not spent in some cases. Under current nonprofit financial reporting rules it is still far too easy for a charity to spend very little on what most donors would think of as a charitable program and purport to be financially efficient. Some AIP F rated charities even clairn in solicitations, tax forms or financial summaries that 80% or more goes to programs or that they have a top rating from a magazine or watchdog that does not question the quality of a charity's self-reported finances.

While there have been some significant improvements in charity financial reporting since AIP's founding, it is still inconsistent, unclear and often incorrect. AIP adjusts a charity's finances to allow for greater consistency and comparability. Charities that dispute AIP's ratings are often quick to claim that they follow GAAP (generally accepted accounting principles). GAAP reporting offers wide latitude in choosing reporting methods and may not be the most useful form of reporting for donors wanting to judge the financial efficiency of charities.

A charity may even count its primary solicitation activity as a charitable program. For instance, Planet Aid, a nonprofit group famous for its yellow outdoor collection boxes, calls the cost of collecting worn clothes, which it later sells, a program service expense. Its tax form states that its purpose is "To support development projects ... and protection of natural habitat through the recycling of used clothing." It would be like Wal-Mart claiming that its main purpose is to help low-income people have a higher standard of living by selling them less expensive merchandise. Planet Aid raises almost all of its funds by selling the donated items, rather than giving them to needy people. It only distributed $8,000 of donated goods of the $8.7 million it spent in 2004, according to its most recently available tax form. Planet Aid's 2004 audit reports two program service expenses: $6.6 million of "Clothing collection" and $2 million of "International Aid." AIP believes the cost to collect used goods for later sale is a fundraising expense and considers any possible benefit to the environment to be incidental. Planet Aid reports a 94% program ratio, whereas AIP believes the ratio earns the group an F grade at 23%.

There are many other ways for charities to inflate their program ratios and lower fundraising percentages. Lots of groups allocate large portions of the cost of direct mail and telemarketing solicitations to program expenses. Others accept large amounts of unidentified donated goods that may be of questionable value to recipients. Some take credit for the contributions and expenses of another group. The cost of acquiring new donors, the bulk of fundraising expenses for most charities, may be falsely identified as a membership program expense in charities' financial reports. The list goes on and on...

The number one mistake that donors make when they give is that they are too overly impressed by one or two accomplishments or good deeds that a charity describes in its solicitations. Donors need to determine how much good is being done in relationship to the resources that a charity receives. This is exactly what AIP's detailed analysis provides in the form of our financial measurements and letter grade ratings.